ET BureauHave debt mutual funds suddenly become too complex for individual investors? Well, a small group of financial advisors seem to think so. They say the variables – think of RBI policy reviews, Brexit, the US Fed, etc –to consider before investing in a debt scheme have multiplied lately. Their solution: don’t look beyond liquid and ultra short-term schemes for your debt investments. The reasoning: a few extra percentage points don’t justify the risk and volatility in other debt schemes. We asked Lakshmi Iyer, head – fixed income and products, Kotak Mutual Fund, whether she shares this viewpoint. Iyer, who has been an active participant in the debt mutual fund space for the last decade and a half, tells Madhu T of ET.com that she doesn’t believe so.
Do you agree with the view that investments in debt mutual funds have become an extremely complex affair for individual investors?
No. I don’t agree with that view. One needs to understand a few things about debt investments.
One, debt as an asset class offers investment solutions to most interest rate cycles – rising, falling, and stable interest rate scenarios. For example, Fixed Maturity Plans (FMPs) work well when interest rates are high, and duration fund works well when interest rates could be heading lower. Hence it is key to ascertain what interest rate scenario one is in and the likely interest rate outlook in the near to medium term. Factors influencing interest rates of course need to be taken into cognizance, but that is true for investment in any asset class and not just in debt investments.
Two, debt as an asset class is considered to be the domain of non-retail (institutional investors) as bulk of debt investments in retail portfolios are dominated by traditional mode of investments like fixed deposits, National Saving Certificate, Public Provident Fund, and the likes.
Also, the media actively track equities over fixed income. Add to it the low level of financial literacy in India, the tendency to equate volatility in debt to that of equities is quite natural – however untrue it may be. One also needs to bear in mind that in debt, one can never lose capital – unless there is a credit default. Hence it is imperative to choose the right kind of strategy
As a witness to the evolution of debt mutual funds over the years, do you think they have become more complex over the years?
Not at all. In fact, with more disclosures things have become a lot more comprehendible than earlier. Investors today ask questions pertaining to modified duration, yield to maturity, etc of the portfolio which was virtually non-existent a few years ago. Just because I don’t know how to drive – does it make driving on roads dangerous or mean that the auto parts are complex to operate? Ignorance may not always be bliss!
What is the need of the hour is to have proper categorisation of the funds and each of those funds would have to follow similar mandate. That is a common definition. For instance, if short term means maturity between one to three years, it should be applicable to all funds categorized under short term to make it much easier for a common man to understand.
What do you think of the advice that regular investor should stay away from long-term debt funds?
If interest rate trajectory is headed lower, why shy away from long term funds? How much to allocate to such funds within the fixed income investment depends on the overall risk taking ability of the investor, apart from the intended investment tenure. If there is an absolute risk aversion, then even ultra short term strategies may not suit such investors as there could be volatility – albeit to a much lesser degree.
But the critics say the volatility may be too much for retail investors to handle.
Today, the retail investors, HNIs and institutional investors have decent exposure to tax-free bonds apart from other corporate bonds in their portfolio. These bond prices also tend to move in line with interest rate movements in the market. If that movement (read volatility) doesn’t disturb the investor, then why should NAV fluctuations in long term funds disturb them? Is this the price being paid for too much transparency offered in mutual fund investments?
For example, when gold and real estate prices witnessed a meltdown way back in 2008, how many investors were aware of the exact drop in the value of their holdings?
Finally, what should be the strategy for retail investors?
The bottom-line is one should look to change the percentage of allocation to short and long term funds, as part of prudent asset allocation, by not shying away from it. For instance, a year back we were advocating 60:40 allocation of Rs 100 debt allocation between short term/accrual funds and long duration funds. With the pace of decline interest rates a tad faster than what we have envisaged, we are currently suggesting 80-85% of fresh allocations to accrual/short duration funds with the remainder in long duration actively-managed funds.
Retail investors should not ignore debt investments in their overall financial portfolio. Like a balanced diet which gives the right proportion of proteins, vitamins, carbohydrates, fats, etc, there is a need to have a balanced financial portfolio which would serve all the future needs.
Assessing interest rate cycles is the key to any investment. If one doesn’t have the necessary resources, the person could engage with an advisor.
Do you agree with the view that investments in debt mutual funds have become an extremely complex affair for individual investors?
No. I don’t agree with that view. One needs to understand a few things about debt investments.
One, debt as an asset class offers investment solutions to most interest rate cycles – rising, falling, and stable interest rate scenarios. For example, Fixed Maturity Plans (FMPs) work well when interest rates are high, and duration fund works well when interest rates could be heading lower. Hence it is key to ascertain what interest rate scenario one is in and the likely interest rate outlook in the near to medium term. Factors influencing interest rates of course need to be taken into cognizance, but that is true for investment in any asset class and not just in debt investments.
Two, debt as an asset class is considered to be the domain of non-retail (institutional investors) as bulk of debt investments in retail portfolios are dominated by traditional mode of investments like fixed deposits, National Saving Certificate, Public Provident Fund, and the likes.
Also, the media actively track equities over fixed income. Add to it the low level of financial literacy in India, the tendency to equate volatility in debt to that of equities is quite natural – however untrue it may be. One also needs to bear in mind that in debt, one can never lose capital – unless there is a credit default. Hence it is imperative to choose the right kind of strategy
As a witness to the evolution of debt mutual funds over the years, do you think they have become more complex over the years?
Not at all. In fact, with more disclosures things have become a lot more comprehendible than earlier. Investors today ask questions pertaining to modified duration, yield to maturity, etc of the portfolio which was virtually non-existent a few years ago. Just because I don’t know how to drive – does it make driving on roads dangerous or mean that the auto parts are complex to operate? Ignorance may not always be bliss!
What is the need of the hour is to have proper categorisation of the funds and each of those funds would have to follow similar mandate. That is a common definition. For instance, if short term means maturity between one to three years, it should be applicable to all funds categorized under short term to make it much easier for a common man to understand.
What do you think of the advice that regular investor should stay away from long-term debt funds?
If interest rate trajectory is headed lower, why shy away from long term funds? How much to allocate to such funds within the fixed income investment depends on the overall risk taking ability of the investor, apart from the intended investment tenure. If there is an absolute risk aversion, then even ultra short term strategies may not suit such investors as there could be volatility – albeit to a much lesser degree.
But the critics say the volatility may be too much for retail investors to handle.
Today, the retail investors, HNIs and institutional investors have decent exposure to tax-free bonds apart from other corporate bonds in their portfolio. These bond prices also tend to move in line with interest rate movements in the market. If that movement (read volatility) doesn’t disturb the investor, then why should NAV fluctuations in long term funds disturb them? Is this the price being paid for too much transparency offered in mutual fund investments?
For example, when gold and real estate prices witnessed a meltdown way back in 2008, how many investors were aware of the exact drop in the value of their holdings?
Finally, what should be the strategy for retail investors?
The bottom-line is one should look to change the percentage of allocation to short and long term funds, as part of prudent asset allocation, by not shying away from it. For instance, a year back we were advocating 60:40 allocation of Rs 100 debt allocation between short term/accrual funds and long duration funds. With the pace of decline interest rates a tad faster than what we have envisaged, we are currently suggesting 80-85% of fresh allocations to accrual/short duration funds with the remainder in long duration actively-managed funds.
Retail investors should not ignore debt investments in their overall financial portfolio. Like a balanced diet which gives the right proportion of proteins, vitamins, carbohydrates, fats, etc, there is a need to have a balanced financial portfolio which would serve all the future needs.
Assessing interest rate cycles is the key to any investment. If one doesn’t have the necessary resources, the person could engage with an advisor.
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